Cash Flow Problems for Small Businesses and What to Do

Good cash flow is an essential aspect of running a successful business. Conversely, poor cash flow can be disastrous for any business. Small business owners often cite cash flow problems as one of the main reasons for their failure.

It's not a bright idea to plan for your business without first planning your cash flow. Fixing cash flow problems early on is essential to preventing them from becoming more significant problems later on.

Even if you're already running a successful business, it's vital to keep an eye on your financial situation regularly and course correct to prevent any potential problems from arising. This publication will address the most common cash flow problems small businesses face and ways to overcome them.

What Are Cash Flow Problems?

Cash flow problems occur when a business does not generate enough cash to pay for its current expenses. Conversely, if cash outflows exceed cash inflow, companies may struggle to meet their debt obligations and other costs.

Net cash outflows aren't necessarily an indication of a cash flow problem. It could be that the company is simply investing its profits back into the business. It's common for companies to experience a net cash outflow when making large payments or undergoing seasonal business instabilities.A cash flow problem arises when outflows exceed inflowing amounts. If that happens, the business can run out of cash reserves and no longer meet its liabilities.

Small business cash flow problems can occur when profits are low, payment collection is complex, or investments exceed cash reserves.

Frequent Cash Flow Problems Small Businesses Face

Regardless of how great your business model may be, how profitable it is, or how many investors are willing to support it, you cannot survive without effectively managing your company's cash flow.

A prominent study by the United States Bank found that 82 percent of startups and small businesses go bankrupt because they don't manage their cash flow properly. So even if you're a sharp entrepreneur in every other way, it's essential to keep your focus on managing your company's finances so that you don't put your business at risk.

Here is a list of the five most common cash flow problems for small businesses:

1. Downplaying Startup Expenses

If you're forming a business, having a realistic budget in place is necessary to help you stay out of financial trouble right from the start. Unfortunately, unrealistic calculations and a lack of a cash reserve may get you off to a bad start. Imagine how difficult it would be to run short of money before you've even had a chance to open your business.

If your overhead costs (such as rent, utilities, etc.) are too high, your business is likely to experience cash flow problems because you won't cover all of your expenses. Expensive rent, car lease, and travel can eat into your profits quickly. If you have high operating costs, you're fighting against the odds. You would need to sell more to break even.

Cutting down on overhead costs can help make a long-term impact on the profitability of your business.

2. Growing Too Soon

Most people want to expand their business, but sometimes growing too fast can cause cash flow issues which can hurt the company.

For example, if you get a large client contract that exceeds your company's current capabilities, you might need to hire additional staff. You'll need to add three new employees to your team to fulfill this request.

However, you don't have enough cash to pay for their wages because you haven't yet received the first payment from the new client, which puts you in an unfavorable cash flow position.

To overcome this problem, you could borrow money from the bank, for example, an overdraft or short-term loan. Often, this is a viable alternative because banks are more likely to lend to a business when they can see a draft contract or letter of intent from the company.

Once you receive payment from the client, you can use that money to pay down the debt. Only interest needs to be paid to the bank for the time you used the cash.

3. Seasonal Fluctuations

Some businesses experience seasonal oscillations in demand for their products and services. If business owners don't account for these changes, their cash flow situation could be less than ideal. However, small business owners who use cash flow projections and accurate sales forecasts can plan for seasonal changes.

4. Over Optimistic Outlook on Future

Optimism is essential for a new business owner but letting it compromise your objectiveness can be dangerous to your financial health.

That's why it's so important to complete the goals and realistic sales forecasts based upon actual numbers and historical evidence. For example, using quantitative forecasting methods, you could utilize your own business's past revenue data or other companies in your industry as a baseline for tracking trends and making predictions about future sales. With this information and some intuitive insight, you'll be able to come up with more realistic sales projections for the future.

It can be challenging to forecast revenue when starting out because you don't have any past sales figures or experience to help. Nevertheless, working with a mentor from your industry can be incredibly helpful. A good business mentor may offer their experiences to help you project future revenues and even offer historical revenue figures from personal experience to estimate future sales volumes.

5. No Cash Cushion

Regardless of how many safeguards you have put into place to protect your company's cash, hiccups are inevitable. If you have some savings already set aside, this may not be a problem for you. However, if your company has no cash reserves, one slow sales month can spell immediate disaster.

To safeguard your business from cash-flow problems, set aside an account balance equivalent to 2 months' worth of operating costs. That way, even if you experience unexpected hold-ups to cash flow, there are reserves in place to protect yourself. 

Conclusion

Cash flow problems are one of the most significant challenges for small business owners. But if you keep an eye out for potential pitfalls and avoid unnecessary spending, you'll be able to stay ahead of cash issues and avoid financial trouble.

Forecasting is difficult. However, it is more challenging to run a company without doing it.